Service Bancorp (SERC) 10-Q 2009 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2008

¨ TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File Number 0-24935

SERVICE BANCORP, INC.

(Exact name of registrant as specified in its charter)

Massachusetts	04-3430806
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification Number)

81 Main Street,

Medway, Massachusetts 02053

(Address and zip code of principal executive offices)

(888) 578-7282

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

Check whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    YES    x  NO    ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	¨	Accelerated filer    ¨
Non-accelerated filer	¨  (Do not check if a smaller reporting company)	Smaller reporting company    x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)    YES    ¨  NO    x

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practical date: At February 11, 2009, there were 1,675,633 shares of common stock outstanding, par value $0.01 per share.

SERVICE BANCORP, INC. AND SUBSIDIARY

FORM 10-Q

Index

		Page
PART I	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Balance Sheets as of December 31, 2008 and June 30, 2008	1
	Consolidated Statements of Operations for the three and six months ended December 31, 2008 and 2007	2
	Consolidated Statements of Changes in Stockholders’ Equity for the six months ended December 31, 2008 and 2007	3
	Consolidated Statements of Cash Flows for the six months ended December 31, 2008 and 2007	4
	Notes to Consolidated Financial Statements	5
Item 2.	Management’s Discussion and Analysis	11
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	18
Item 4.	Controls and Procedures	18
PART II	OTHER INFORMATION
Item 1.	Legal Proceedings	19
Item 1A.	Risk Factors	19
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	20
Item 3.	Defaults upon Senior Securities	20
Item 4.	Submission of Matters to a Vote of Security Holders	20
Item 5.	Other Information	20
Item 6.	Exhibits	21
	Signatures	22

PART I—FINANCIAL INFORMATION

ITEM 1. Financial Statements

SERVICE BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS (unaudited)

(Dollars in thousands, except share amounts)

	December 31, 2008			June 30, 2008
ASSETS
Cash and due from banks	$	4,854		$	6,767
Short-term investments		17			1,991
Total cash and cash equivalents		4,871			8,758
Securities available for sale, at fair value		29,044			50,301
Securities held to maturity, at amortized cost		1,010			1,176
Federal Home Loan Bank stock, at cost		6,530			6,530
Loans		323,988			330,780
Less allowance for loan losses		(3,574	)		(3,307	)
Loans, net		320,414			327,473
Banking premises and equipment, net		4,766			4,962
Accrued interest receivable		1,421			1,590
Net deferred tax asset		5,893			2,370
Bank-owned life insurance		5,321			5,223
Other real estate owned		4,625			3,684
Other assets		3,110			3,009
Total assets	$	387,005		$	415,076
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits	$	244,392		$	260,768
Borrowings		117,798			122,121
Subordinated debentures		3,093			3,093
Other liabilities		1,981			3,285
Total liabilities		367,264			389,267
Commitments and contingencies (Note 4)
Stockholders’ equity:
Preferred stock, $.01 par value, 5,000,000 shares authorized, none issued		—			—
Common stock, $.01 par value, 12,000,000 shares authorized, 1,712,630 shares issued		17			17
Additional paid-in capital		8,149			8,351
Retained earnings		13,896			19,949
Accumulated other comprehensive loss		(1,401	)		(1,367	)
Treasury stock, at cost (36,997 and 53,037 shares, respectively)		(723	)		(1,025	)
Unearned restricted shares (20,462 and 6,927 shares, respectively)		(197	)		(116	)
Total stockholders’ equity		19,741			25,809
Total liabilities and stockholders’ equity	$	387,005		$	415,076

See accompanying notes to consolidated financial statements.

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SERVICE BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)

(Dollars in thousands, except share amounts)

	Three Months Ended December 31,						Six Months Ended December 31,
	2008			2007			2008			2007
Interest and dividend income:
Interest and fees on loans	$	4,820		$	5,220		$	9,750		$	10,390
Interest and dividends on securities and Federal Home Loan Bank stock		552			756			1,263			1,541
Interest on short-term investments		7			14			18			28
Total interest and dividend income		5,379			5,990			11,031			11,959
Interest expense:
Interest on deposits		1,399			1,871			2,808			3,766
Interest on borrowings		1,256			1,416			2,575			2,906
Interest on subordinated debentures		60			64			107			129
Total interest expense		2,715			3,351			5,490			6,801
Net interest income		2,664			2,639			5,541			5,158
Provision for loan losses		230			340			520			860
Net interest income, after provision for loan losses		2,434			2,299			5,021			4,298
Non-interest income:
Customer service fees		333			321			641			641
Mortgage banking gains, net		16			6			21			10
Securities sales (losses) gains, net		(104	)		109			(172	)		200
Loss on write-down of investments to fair value		(200	)		—			(8,712	)		—
Other income		73			127			193			281
Total non-interest income (loss)		118			563			(8,029	)		1,132
Non-interest expense:
Salaries and employee benefits		1,418			1,376			2,981			2,909
Occupancy		386			377			775			755
Data processing		291			351			594			628
Equipment		99			118			211			233
Professional fees		322			210			584			359
Advertising		18			72			44			158
Foreclosed real estate		118			69			212			92
Other general and administrative		726			355			1,309			752
Total non-interest expense		3,378			2,928			6,710			5,886
Loss before income taxes		(826	)		(66	)		(9,718	)		(456	)
Income tax benefit		(2,787	)		(46	)		(3,665	)		(212	)
Net income (loss)	$	1,961		$	(20	)	$	(6,053	)	$	(244	)
Weighted average shares outstanding – basic		1,653,955			1,645,385			1,653,442			1,644,483
Weighted average shares outstanding – diluted		1,662,645			1,645,385			1,653,442			1,644,483
Earnings (loss) per share – basic	$	1.19		$	(0.01	)	$	(3.66	)	$	(0.15	)
Earnings (loss) per share – diluted	$	1.18		$	(0.01	)	$	(3.66	)	$	(0.15	)

See accompanying notes to consolidated financial statements.

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SERVICE BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (unaudited)

SIX MONTHS ENDED DECEMBER 31, 2008 AND 2007

(Dollars in thousands, except share amounts)

	Common Stock		Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Treasury Stock			Unearned Restricted Shares			Total
Balance at June 30, 2007	$	17	$	8,475		$	22,598		$	(427	)	$	(1,203	)	$	(152	)	$	29,308
Comprehensive income:
Net loss		—		—			(244	)		—			—			—			(244	)
Net unrealized gain on securities available for sale, net of taxes and reclassification adjustment		—		—			—			432			—			—			432
Total comprehensive income																			188
Purchase of treasury stock (3,200 shares)		—		—			—			—			(81	)		—			(81	)
Forfeiture of restricted stock (3,000 shares)		—		—			—			—			(81	)		61			(20	)
Stock option exercises (9,500 shares)		—		(57	)		—			—			181			—			124
Income tax benefit on options exercised		—		2			—			—			—			—			2
Amortization of restricted stock (939 shares)		—		2			—			—			—			24			26
Balance at December 31, 2007	$	17	$	8,422		$	22,354		$	5		$	(1,184	)	$	(67	)	$	29,547

	Common Stock		Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Loss			Treasury Stock			Unearned Restricted Shares			Total
Balance at June 30, 2008	$	17	$	8,351		$	19,949		$	(1,367	)	$	(1,025	)	$	(116	)	$	25,809
Comprehensive loss:
Net loss		—		—			(6,053	)		—			—			—			(6,053	)
Net unrealized loss on securities available for sale, net of taxes and reclassification adjustment		—		—			—			(34	)		—			—			(34	)
Total comprehensive loss																			(6,087	)
Restricted stock granted (18,000 shares)		—		(200	)		—			—			348			(148	)		—
Forfeiture of restricted stock (1,960 shares)		—		—			—			—			(46	)		46			—
Amortization of restricted stock (2,505 shares)		—		(2	)		—			—			—			21			19
Balance at December 31, 2008	$	17	$	8,149		$	13,896		$	(1,401	)	$	(723	)	$	(197	)	$	19,741

See accompanying notes to consolidated financial statements.

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SERVICE BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

(Dollars in thousands)

	Six Months Ended December 31,
	2008			2007
Cash flows from operating activities:
Net loss	$	(6,053	)	$	(244	)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Provision for loan losses		520			860
Net loss (gain) on securities		172			(200	)
Loss on write-down of investments to fair value		8,712			—
Loans originated for sale		(3,031	)		(2,533	)
Sales of loans originated for sale		2,572			2,353
Net accretion of securities		(9	)		(150	)
Depreciation and amortization expense		216			232
Stock-based compensation		19			26
Decrease in accrued interest receivable		169			243
Net amortization of deferred loan costs and premiums		86			84
Increase in bank-owned life insurance		(98	)		(92	)
Deferred tax benefit		(3,505	)		(193	)
Other, net		(1,350	)		(78	)
Net cash (used in) provided by operating activities		(1,580	)		308
Cash flows from investing activities:
Activity in securities available for sale:
Sales		10,448			14,783
Maturities, prepayments and calls		2,269			3,002
Purchases		(384	)		(11,658	)
Activity in securities held to maturity:
Maturities, prepayments and calls		163			147
Net increase (decrease) in loans, excluding loan purchases and sales		4,822			(5,608	)
Sales of other real estate owned		1,094			306
Purchase of banking premises and equipment		(20	)		(79	)
Purchase of Federal Home Loan Bank stock		—			(428	)
Net cash provided by investing activities		18,392			465
Cash flows from financing activities:
Net decrease in deposits		(16,376	)		(14,571	)
Proceeds from long-term borrowings		25,000			43,500
Repayment of long-term borrowings		(31,053	)		(24,049	)
Net increase (decrease) in short-term borrowings		1,730			(7,050	)
Purchase of treasury stock		—			(81	)
Stock option exercises		—			124
Net cash used in financing activities		(20,699	)		(2,127	)
Net change in cash and cash equivalents		(3,887	)		(1,354	)
Cash and cash equivalents at beginning of year		8,758			9,385
Cash and cash equivalents at end of year	$	4,871		$	8,031
Supplementary information:
Interest paid on deposits	$	2,822		$	3,766
Interest paid on borrowings and subordinated debt		2,687			2,916
Income taxes paid, net of refunds		17			26
Loans transferred to other real estate owned		2,090			769

See accompanying notes to consolidated financial statements.

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SERVICE BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(1) Basis of Presentation and Consolidation

The accompanying unaudited consolidated financial statements include the accounts of Service Bancorp, Inc. (the “Company”) and its wholly-owned subsidiary, Strata Bank (the “Bank”), a Massachusetts chartered savings bank, and the Bank’s wholly-owned subsidiaries, Medway Security Corporation and Franklin Village Security Corporation, both of which engage solely in the purchase and sale of securities. All significant intercompany balances and transactions have been eliminated in consolidation.

These unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and the instructions for Form 10-Q and Item 310(b) of Regulation S-B. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation and in order to make the financial statements not misleading have been included. Interim results are not necessarily indicative of the results that may be expected for the entire year. Certain information and footnote disclosures normally included in the financial statements prepared in accordance with GAAP have been omitted. A summary of significant accounting policies followed by the Company is set forth in the Notes to Consolidated Financial Statements of the Company’s Annual Report on Form 10-K for the year ended June 30, 2008.

(2) Recent Developments

On December 8, 2008, the Company announced the signing of an Agreement and Plan of Merger (the “Agreement”) under which the Bank will be merged into Middlesex Savings Bank (“Middlesex”), headquartered in Natick, Massachusetts. Pursuant to the Agreement, the Company’s mutual holding company structure will be eliminated and the Bank will re-mutualize and merge with Middlesex. The transaction is expected to close in the spring of 2009, subject to several conditions, including the receipt of regulatory approvals and the approval of the Company’s stockholders and the corporators of Service Bancorp, MHC and a mutual holding company to be formed by Middlesex.

(3) Earnings per Share

Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares (common stock equivalents) that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate to outstanding stock options and unvested restricted stock and are determined using the treasury stock method. Assumed conversion of the outstanding dilutive stock options and unvested restricted stock would increase the shares outstanding but would not require an adjustment to income as a result of the conversion.

Weighted average diluted shares outstanding have been calculated based on the following:

	Quarter Ended December 31,		Six Months Ended December 31,
	2008	2007	2008	2007
Weighted average shares outstanding	1,653,955	1,645,385	1,653,442	1,644,483
Effect of dilutive stock options	2,808	—	—	—
Effect of unvested shares of restricted stock	5,882	—	—	—
Weighted average diluted shares outstanding	1,662,645	1,645,385	1,653,442	1,644,483

For the six months ended December 31, 2008 and for the quarter and six months ended December 31, 2007, as a result of the Company reporting a net loss, all outstanding stock options and unvested shares of restricted stock were anti-dilutive and therefore excluded from the earnings per share calculations. For the quarter ended December 31, 2008, 16,307 vested stock option shares were anti-dilutive and therefore excluded from the earnings per share calculations. For the six months ended December 31, 2008, 24,997 vested stock option shares and 19,708 unvested restricted stock shares were anti-dilutive and therefore excluded from the earnings per share calculations. For the quarter ended December 31, 2007, 29,060 vested stock option shares and 2,760 unvested restricted stock shares were anti-dilutive and therefore excluded from the earnings per share calculations. For the six months ended December 31, 2007, 31,987 vested stock option shares and 2,760 unvested restricted stock shares were anti-dilutive and therefore excluded from the earnings per share calculations.

-5-

SERVICE BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(4) Commitments

At December 31, 2008, the Company had outstanding commitments to originate loans of $2.3 million. Unused lines of credit and open commitments available to customers at December 31, 2008 amounted to $40.5 million, of which $21.9 million were home equity lines of credit.

(5) Securities

The following table sets forth the Company’s securities at the dates indicated:

	December 31, 2008				June 30, 2008
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
	(Dollars in thousands)
Securities Available for Sale
Government sponsored enterprise obligations	$	3,593	$	3,676	$	6,578	$	6,664
Government sponsored enterprise mortgage-backed securities		16,156		16,716		21,966		21,878
Other debt securities		7,133		5,425		12,487		11,466
Municipal securities		1,798		1,777		1,798		1,744
Total debt securities available for sale		28,680		27,594		42,829		41,752
Marketable equity securities		2,498		1,450		9,552		8,549
Total securities available for sale	$	31,178	$	29,044	$	52,381	$	50,301
Securities Held to Maturity
Government sponsored enterprise mortgage-backed securities	$	1,010	$	1,056	$	1,176	$	1,210

On September 30, 2008, the Company recorded other-than-temporary impairment (“OTTI”) charges of $6.6 million related to the its investments in preferred securities issued by the Federal National Mortgage Association (“FNMA”) and the Federal Home Loan Mortgage Corporation (“FHLMC”) and $1.9 million related to its investments related to corporate bonds issued by Lehman Brothers Holdings. On December 31, 2008, the Company recorded an OTTI charge of $200,000 related to its investment in common stock issued by Citigroup.

-6-

SERVICE BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(6) Loans

The following table presents data relating to the composition of the Company’s loan portfolio by type of loan at the dates indicated:

	December 31, 2008					June 30, 2008
	Amount			Percent		Amount			Percent
	(Dollars in thousands)
Real estate loans:
One- to four-family residential	$	170,722		52.83	%	$	171,519		51.99	%
Commercial and multi-family		91,088		28.19			86,879		26.34
Commercial construction		8,497		2.63			18,408		5.58
Residential construction		908		0.28			1,942		0.59
Residential loans held for sale		459		0.14			—		—
Total real estate loans		271,674		84.07			278,748		84.50
Commercial loans		27,546		8.53			27,373		8.30
Consumer loans:
Home equity		17,179		5.32			16,723		5.07
Second mortgages		5,837		1.81			6,206		1.88
Passbook secured		286		0.09			256		0.08
Other		571		0.18			555		0.17
Total consumer loans		23,873		7.40			23,740		7.20
Total gross loans		323,093		100.00	%		329,861		100.00	%
Net deferred loan costs and premiums		895					919
Allowance for loan losses		(3,574	)				(3,307	)
Total loans, net	$	320,414				$	327,473

(7) Deposits

The following table indicates types and balances in deposit accounts at the dates indicated:

	December 31, 2008				June 30, 2008
	Amount		Percent		Amount		Percent
	(Dollars in thousands)
Demand	$	33,557	13.73	%	$	39,120	15.00	%
NOW		14,376	5.88			18,987	7.28
Money market deposits		14,414	5.90			12,255	4.70
Regular and other savings		48,078	19.67			56,348	21.61
Total non-certificate accounts		110,425	45.18			126,710	48.59
Term certificates of $100,000 or greater		55,407	22.67			58,995	22.62
Term certificates less than $100,000		78,560	32.15			75,063	28.79
Total certificate accounts		133,967	54.82			134,058	51.41
Total deposits	$	244,392	100.00	%	$	260,768	100.00	%

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SERVICE BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(8) Borrowings

As of December 31, 2008, there were $4.1 million at a rate of 0.06% in overnight borrowings with the Federal Home Loan Bank of Boston (“FHLB”), compared to $2.4 million at a rate of 2.50% as of June 30, 2008. In addition, borrowings included the following advances from the FHLB and are presented by the earlier of the maturity date or the callable date by the FHLB.

	December 31, 2008				June 30, 2008
	Amount		Percent		Amount		Percent
	(Dollars in thousands)
Less than one year	$	63,000	55.40	%	$	44,000	36.74	%
One to three years		43,996	38.69			66,039	55.14
Greater than three years		6,717	5.91			9,727	8.12
Total	$	113,713	100.00	%	$	119,766	100.00	%

(9) Subordinated Debentures

In March 2004, Service Capital Trust I (“Trust I”), a special purpose trust sponsored by the Company, participated in a pooled offering of trust preferred securities. In connection with this offering, Trust I issued $3.1 million of trust preferred securities and reinvested the proceeds in a 30-year $3.1 million junior subordinated debenture issued by the Company. Interest is calculated on the subordinated debenture and trust preferred securities at a rate equal to the three-month London Interbank Offering Rate plus 285 basis points. The junior subordinated debenture represents the sole asset of Trust I. The Company has guaranteed, on a subordinated basis, distributions and other payments due on the trust preferred securities (the “Guarantee”). The Guarantee, when taken together with the Company’s obligations under (i) the junior subordinated debentures; (ii) the indenture pursuant to which the junior subordinated debentures was issued; and (iii) the Amended and Restated Declaration of Trust governing Trust I, constitutes a full and unconditional guarantee of Trust I’s obligations under the trust preferred securities.

Under regulatory capital guidelines, trust preferred securities, within certain limitations, qualify as regulatory capital. Trust I, consistent with the FASB Interpretation No. 46, “Variable Interest Entities”, is not consolidated in the consolidated financial statements of the Company. Therefore, the Company presents in its consolidated financial statements junior subordinated debt as a liability and its investment in Trust I as a component of other assets.

(10) Stock Repurchase Plan

In February 2003, the Board of Directors of the Company approved a Stock Repurchase Plan under which the Company is authorized to acquire up to 4% of the outstanding common stock, or up to approximately 65,925 shares of the issued and outstanding shares of its common stock in the open market or in private transactions. Under the Stock Repurchase Plan, shares may be repurchased from time to time and in such amounts as market conditions warrant, and subject to regulatory considerations. In September 2008, the Board of Directors terminated the Stock Repurchase Plan, and the Company does not expect to repurchase shares for the foreseeable future. Prior to termination, 59,428 shares had been repurchased under the plan at an average price of $25.18.

-8-

SERVICE BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(11) Fair Value Measurement

Effective July 1, 2008, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements,” which provides a framework for measuring fair value in accordance with generally accepted accounting principles.

SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact. In October 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position No. 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active” (“FSP No. 157-3”). FSP No. 157-3 clarifies the application of SFAS No. 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. FSP No. 157-3 was effective immediately upon issuance, and includes prior periods for which financial statements have not been issued. The Company applied the guidance contained in FSP No. 157-3 in determining fair values at December 31, 2008, and it did not have a material impact on the consolidated financial statements.

SFAS No. 157 requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, SFAS No. 157 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

• Level 1 Inputs - Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

• Level 2 Inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.

• Level 3 Inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of the Company’s financial assets carried at fair value effective July 1, 2008.

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality, the Company’s creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

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SERVICE BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

Securities Available for Sale. Equity securities are reported at fair value utilizing Level 1 inputs based on quoted market prices. Other securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.

Impaired Loans. Impaired loans are reported at the fair value as based primarily on the appraised value of the collateral. Appraised values are typically based on a blend of (a) an income approach using unobservable cash flows to measure fair value, and (b) a market approach using observable market comparables. These appraised values may be discounted based on management’s historical knowledge, expertise or changes in market conditions from the time of valuation. For these reasons, impaired loans are categorized as Level 3 assets.

Financial assets and financial liabilities measured at fair value on a recurring basis as of December 31, 2008, segregated by the level of valuation inputs within the fair value hierarchy, are summarized below:

	Level 1 Inputs		Level 2 Inputs		Level 3 Inputs		Total Fair Value
	(In thousands)
Assets:
Securities available for sale:
Government sponsored enterprise obligations	$	—	$	3,676	$	—	$	3,676
Government sponsored enterprise mortgage-backed securities		—		16,716		—		16,716
Other debt securities		—		5,425		—		5,425
Municipal securities		—		1,777		—		1,777
Marketable equity securities		1,450		—		—		1,450
Total assets	$	1,450	$	27,594	$	—	$	29,044

Financial assets measured at fair value on a non-recurring basis as of December 31, 2008, segregated by the level of valuation inputs within the fair value hierarchy, are summarized below:

	Level 1		Level 2		Level 3
	(In thousands)
Assets:
Impaired loans	$	—	$	—	$	3,644
Total assets	$	—	$	—	$	3,644

The Company also adopted SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115” as of July 1, 2008. SFAS No. 159 allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis. The Company did not elect fair value treatment for any financial assets or liabilities upon adoption.

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ITEM 2. Management’s Discussion and Analysis

General

This quarterly report on Form 10-Q contains forward-looking statements. For this purpose, statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words “believe”, “anticipates”, “plans”, “expects” and similar expressions are intended to identify forward-looking statements. There are a number of important factors that could cause the Company’s actual results to differ materially from those contemplated by such forward-looking statements. These important factors include, without limitation, competitive conditions in the Bank’s marketplace generally, the Bank’s continued ability to originate quality loans, fluctuation in interest rates including fluctuations which may affect the Bank’s interest rate spread, real estate conditions in the Bank’s lending areas, changes in the securities or financial markets, changes in loan defaults and charge-off rates, general and local economic conditions, the Bank’s continued ability to attract and retain deposits, the Company’s and the Bank’s ability to control costs, new accounting pronouncements, and changing regulatory requirements. The Company undertakes no obligation to publicly release the results of any revisions to those forward-looking statements, which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

Comparison of Financial Condition at December 31, 2008 and June 30, 2008

Total assets were $387.0 million at December 31, 2008, a decrease of $28.1 million, or 6.8%, from $415.1 million at June 30, 2008. Net loans decreased $7.1 million, or 2.2%, to $320.4 million. The investment securities portfolio decreased $21.4 million, or 36.9%, since June 30, 2008 to $36.6 million at December 31, 2008. Short-term investments, which consist mostly of money market mutual fund investments and overnight federal funds sold, decreased $2.0 million. Total deposits decreased $16.4 million, or 6.3%, since June 30, 2008 to $244.4 million at December 31, 2008. Borrowings decreased $4.3 million, or 3.5%, since June 30, 2008.

Total investment securities, excluding FHLB stock, were $30.0 million at December 31, 2008, a decrease of $21.4 million, or 41.6%, since June 30, 2008. This decline was primarily due to OTTI charges totaling $8.7 million, securities sales and maturities and an increase in unrealized losses on securities available for sale due to unfavorable changes in the market prices for corporate debt and equity securities since June 30, 2008. On December 31, 2008, the Company recorded an OTTI charge related to its investment in common stock issued by Citigroup of $200,000. This write-down follows the OTTI charges recorded on September 30, 2008 related to investments in preferred securities issued by FNMA and FHLMC of $6.6 million and in corporate bonds issued by Lehman Brothers Holdings of $1.9 million.

Residential real estate loans are originated through the residential mortgage division of the Bank, the Strata Mortgage Center. During the six months ended December 31, 2008, the Strata Mortgage Center originated $11.1 million in residential real estate loans, which was $8.8 million, or 44.2%, lower than the same period last year. Also during the six months ended December 31, 2008, the Bank sold $2.6 million in residential loans compared with residential loan sales of $2.4 million during the same period last year. As of December 31, 2008, residential loans held for sale totaled $459,000 compared to no residential loans held for sale as of June 30, 2008. Total residential mortgage portfolio loans, net of principal payments, decreased $1.8 million, or 1.1%, since June 30, 2008 to $171.6 million at December 31, 2008. The Company expects to continue to reduce the amount of loans held in portfolio and have a small increase in residential loan sales compared to the year ended June 30, 2008. Home equity and second mortgage loans increased $87,000, or 0.4%, since June 30, 2008 to $23.0 million at December 31, 2008 as new loans and advances exceeded loan amortization.

Total commercial loans, comprised of commercial real estate, construction and commercial business loans, decreased $5.5 million, or 4.2%, since June 30, 2008 to $127.1 million. The Bank originated $9.5 million in commercial, commercial real estate and construction loans and lines of credit since June 30, 2008, which was $2.6 million, or 38.4%, higher than the $6.9 million originated during the same period last year. The continuing low level of commercial originations reflects the slower commercial real estate and construction loan market due to declines in new home sales, higher levels of residential construction loan inventory in the market area and competitive loan pricing pressures. The Company expects to have reductions in commercial loans for the year ending June 30, 2009 compared to the year ended June 30, 2008 as the Bank seeks to reduce its risk profile, including non-accruing loans, and strengthen its regulatory capital ratios.

Other real estate owned (“OREO”) totaled $4.6 million at December 31, 2008, representing an increase of $942,000 from $3.7 million at June 30, 2008, reflecting three commercial real estate properties totaling $2.1 million acquired through foreclosure and OREO sales totaling $1.1 million during the six months ended December 31, 2008. Net deferred tax assets were $5.9 million at December 31, 2008, an increase of $3.5 million from $2.4 million at June 30, 2008, due to the benefit for deferred income taxes of $3.5 million during the six months ended December 31, 2008. Management performed an analysis of the realizability of the Company’s deferred tax assets as of December 31, 2008, and determined that is more likely than not that the taxes are realizable.

Total deposits decreased $16.4 million, or 6.3%, since June 30, 2008 to $244.4 million at December 31, 2008. Demand deposits, savings, and NOW deposits decreased $5.6 million, $8.3 million, and $4.6 million, respectively. The decreases in these categories reflected customer transfers to the Company’s higher yielding certificates of deposit and money market deposits, as well as

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outflows. The decrease in NOW deposits was also significantly affected by lower balances in certain NOW accounts used by attorneys in connection with residential loan closings, as influenced by the slower residential loan market during the six months ended December 31, 2008. Money market deposits increased $2.2 million, or 17.6%, to $14.4 million, and retail certificates of deposit decreased only slightly to $134.0 million.

Borrowings decreased $4.3 million, or 3.5%, since June 30, 2008. The Company reduced term advances from the Federal Home Loan Bank of Boston (“FHLB”) by $6.0 million, or 5.1%, while overnight borrowings from the FHLB were increased by $1.7 million, since June 30, 2008, as an alternative to deposits as a source of liquidity. The Company expects to continue to utilize several sources of liquidity as the need for additional funds arises, including, but not limited to, additional core deposits and certificates of deposit and borrowings from the FHLB.

Stockholders’ equity decreased to $19.7 million, or $11.93 book value per share, at December 31, 2008 from $25.8 million, or $15.62 book value per share, at June 30, 2008. The Company’s ratio of stockholders’ equity to total assets at December 31, 2008 was 5.10%, compared to 6.22% at June 30, 2008. These decreases were primarily due to the year-to-date net loss of $6.1 million. For additional information regarding the Bank’s regulatory capital ratios, refer to “–Liquidity and Capital Resources,” below.

Non-Performing Assets and Allowance for Loan Losses – Critical Accounting Estimate

The following table sets forth the Company’s non-performing assets at the dates indicated.

	December 31, 2008			June 30, 2008
	(Dollars in thousands)
Non-accruing loans:
One- to-four-family residential	$	1,275		$	223
Commercial and multi-family real estate		4,221			4,582
Commercial		482			997
Consumer		132			—
Total		6,110			5,802
Accruing loans delinquent more than 90 days		—			—
OREO		4,625			3,684
Total non-performing assets	$	10,735		$	9,486
Total as a percentage of total assets		2.77	%		2.28	%

Non-performing loans totaled $6.1 million at December 31, 2008, representing an increase of $1.5 million, or 32.7%, from $4.6 million at September 30, 2008, and an increase of $308,000, or 5.3%, from $5.8 million at June 30, 2008. Non-performing loans at December 31, 2008 were comprised of six commercial real estate loan relationships totaling $4.2 million, five commercial business loan relationships totaling $482,000, five residential loans totaling $1.3 million and three home equity loan relationships totaling $132,000. Additions to non-performing loans during the quarter ended December 31, 2008 included $2.0 million of commercial loans that were not delinquent, but were placed on non-performing status due to deterioration in the financial condition of the borrowers or because payment in full of principal and interest is not expected.

Other real estate owned (OREO) totaled $4.6 million at December 31, 2008, representing increases of $1.9 million from $2.7 million at September 30, 2008 and $942,000 from $3.7 million at June 30, 2008. OREO at December 31, 2008 was comprised of one completed commercial construction property of $2.6 million, and three commercial real estate properties totaling $2.0 million acquired through foreclosure during the quarter ended December 31, 2008. During the six months ended December 31, 2008, the Company sold two commercial real estate properties with initial fair values at their dates of foreclosure of $1.0 million and a condominium unit for $110,000 from the completed commercial construction property.

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The allowance for loan losses totaled $3.6 million at December 31, 2008, compared to $3.3 million at June 30, 2008. The following table sets forth activity in the Company’s allowance for loan losses for the periods indicated:

	For the Three Months Ended December 31,						For the Six Months Ended December 31,
	2008			2007			2008			2007
	(Dollars in thousands)
Balance at beginning of period	$	3,481		$	3,380		$	3.307		$	3,144
Provision for loan losses		230			340			520			860
Charge-offs:
One-to-four family residential		—			—			—			—
Commercial and multi-family real estate		(55	)		—			(55	)		(30	)
Consumer		(9	)		(7	)		(11	)		(14	)
Commercial business loans		(75	)		(286	)		(194	)		(533	)
Total		(139	)		(293	)		(260	)		(577	)
Recoveries		2			39			7			39
Net charge-offs		(137	)		(254	)		(253	)		(538	)
Balance at end of period	$	3,574		$	3,466		$	3,574		$	3,466
Ratio of net charge-offs (annualized) to average loans during the period		0.17	%		030	%		0.15	%		0.32	%

The provision for loan losses was $230,000 for the quarter ended December 31, 2008, a decline of $110,000, or 32.4%, compared to the $340,000 recorded for the same quarter last year. For the six months ended December 31, 2008, the provision for loan losses was $520,000, a decline of $340,000, or 39.5%, compared to the $860,000 recorded for the same period last year. The allowance for loan losses as a percentage of loans was 1.10% at December 31, 2008, compared to 1.00% at June 30, 2008. The loan loss provisions and the resulting allowance for loan losses were based primarily on management’s assessment of several key factors, including internal loan review classifications reflecting loan relationships deemed by the Company to be impaired, historical loss experience, changes in portfolio size and composition, and current economic conditions. The valuation allowance related to impaired loans totaled $315,000 at December 31, 2008 compared with $158,000 at June 30, 2008.

While management believes that, based on information currently available, the allowance for loan losses is sufficient to cover losses inherent in the Bank’s loan portfolio at this time, no assurances can be given that the level of the allowance will be sufficient to cover loan losses or that future adjustments to the allowance will not be necessary if economic and/or other conditions differ substantially from the economic and other conditions considered by management in evaluating the adequacy of the current level of the allowance. In addition, the Federal Deposit Insurance Corporation (“FDIC”), as an integral part of their examination process, periodically reviews the Bank’s allowance for loan losses. The FDIC may require the Bank to adjust the allowance for loan losses based upon judgments different from those of management. For a further discussion of the allowance, refer to “Allowance for Loan Losses” in Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s Annual Report on Form 10-K for the year ended June 30, 2008.

Comparison of Operating Results for the Quarter and Six Months Ended December 2008 and 2007

Overview

Operating results are primarily dependent on the Bank’s net interest income, which is the difference between the interest earned on the Bank’s earning assets (short-term investments, loans, and securities) and the interest paid on deposits and borrowings. Operating results are also affected by provisions for loan losses, the level of income from non-interest sources such as fees and sales of securities and residential loans, operating expenses and income taxes. Operating results are also significantly affected by general economic conditions, particularly changes in interest rates, as well as government policies and actions of regulatory authorities.

Net income for the quarter ended December 31, 2008 was $2.0 million, or $1.18 per diluted share, compared with a net loss of $20,000, or $0.01 per diluted share, for the same quarter a year ago. The increase in earnings during the quarter ended December 31, 2008 was due to a higher income tax benefit of $2.8 million, reflecting a $2.5 million tax benefit recognized in October on the FNMA and FHLMC OTTI losses recorded on September 30, 2008. Also during the quarter ended December 31, 2008, a higher net interest income of $25,000, or 1.0%, and a lower loan loss provision of $110,000, or 32.4%, were more than offset by a decline in non-interest income of $445,000 or 79.0% and higher non-interest expenses of $451,000, or 15.4%. The net loss for the six months ended December 31, 2008 was $6.1 million, or $3.66 per diluted share, compared with a net loss of $244,000, or $0.15 per diluted share, for the same period a year ago. The increased net loss during the six months ended December 31, 2008 was due to lower other non-interest income of $9.2 million, reflecting OTTI losses of $8.7 million, and higher non-interest expenses of $824,000, or 14.0%, partially offset by higher net interest income of $383,000, or 7.4%, a lower loan loss provision of $340,000, or 39.5%, and a higher tax benefit of $3.7 million.

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Net Interest Income

Net interest income for the quarter ended December 31, 2008 was $2.7 million, an increase of $25,000, or 0.9%, compared with same period last year. This increase was primarily due to a decrease of 73 basis points in the cost of interest-bearing liabilities to 3.13%, which was substantially offset by a decrease of 36 basis points in the yield on interest-earning assets to 5.79% and a $17.8 million decrease in net average interest-earning assets to $27.7 million. The net interest rate spread and net interest margin were 2.66% and 2.86%, respectively, for the quarter ended December 31, 2008, compared to 2.29% and 2.74%, respectively, for the same quarter last year. For the six months ended December 31, 2008, net interest income was $5.5 million, an increase of $383,000, or 7.4%, compared with the same period last year. This increase was primarily due to a decrease of 75 basis points in the cost of interest-bearing liabilities to 3.14%, which was partially offset by a decrease of 28 basis points in the yield on interest-earning assets to 5.83% and a $13.0 million decrease in net average interest-earning assets to $32.4 million. The net interest rate spread and net interest margin were 2.69% and 2.91%, respectively, for the six months ended December 31, 2008, compared to 2.22% and 2.67%, respectively, for the same period last year.

The following tables present, for the periods indicated, the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the amount of interest expense on average interest-bearing liabilities, expressed both in dollars and rates. No tax equivalent adjustments were made. Average balances are derived from the best available daily or monthly data, which management believes approximates the average balances computed on a daily basis. Non-accruing loans have been included in the tables:

	Three Months Ended December 31,
	2008							2007
	Average Balance		Interest Earned/ Paid			Yield/ Rate		Average Balance		Interest Earned/ Paid			Yield/ Rate
	(Dollars in thousands)
Interest-earning assets:
Loans (1)	$	324,242	$	4,820		5.92	%	$	332,270	$	5,220		6.25	%
Securities (2)		43,510		552		5.07			54,491		756		5.55
Short-term investments		2,123		7		1.31			1,268		14		4.42
Total interest-earning assets		369,875		5,379		5.79			388,029		5,990		6.15
Non-interest-earning assets		27,189							21,992
Total assets	$	397,064						$	410,021
Interest-bearing liabilities:
Savings deposits	$	48,386		126		1.03		$	52,848		224		1.68
Money market deposits		15,516		74		1.89			10,450		47		1.78
NOW accounts		14,567		4		0.11			19,531		9		0.18
Certificates of deposit		134,778		1,178		3.47			123,484		1,433		4.60
Brokered certificates of deposit		2,174		17		3.10			11,934		158		5.25
Total interest-bearing deposits		215,421		1,399		2.58			218,247		1,871		3.40
Borrowings and subordinated debt		126,761		1,316		4.06			124,315		1,480		4.66
Total interest-bearing liabilities		342,182		2,715		3.13			342,562		3,351		3.86
Demand deposits		33,456							35,272
Other non-interest bearing liabilities		1,770							2,382
Stockholders’ equity		19,656							29,805
Total liabilities and stockholders’ equity	$	397,064						$	410,021
Net interest income			$	2,664						$	2,639
Net interest rate spread						2.66	%						2.29	%
Net earning assets	$	27,693						$	45,467
Net interest margin						2.86	%						2.74	%
Average interest-earning assets to average interest-bearing liabilities				108.09	%						113.27	%

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	Six Months Ended December 31,
	2008							2007
	Average Balance		Interest Earned/ Paid			Yield/ Rate		Average Balance		Interest Earned/ Paid			Yield/ Rate
	(Dollars in thousands)
Interest-earning assets:
Loans (1)	$	325,468	$	9,750		5.97	%	$	331,211	$	10,390		6.24	%
Securities (2)		49,587		1,263		5.09			57,397		1,541		5.37
Short-term investments		2,081		18		1.72			1,195		28		4.85
Total interest-earning assets		377,136		11,031		5.83			389,803		11,959		6.11
Non-interest-earning assets		26,304							21,901
Total assets	$	403,440						$	411,704
Interest-bearing liabilities:
Savings deposits	$	50,887		271		1.06		$	54,173		477		1.75
Money market deposits		14,683		133		1.80			10,894		98		1.78
NOW accounts		15,503		8		0.10			20,326		19		0.19
Certificates of deposit		135,728		2,356		3.44			122,294		2,832		4.59
Brokered certificates of deposit		2,554		40		3.11			12,756		340		5.29
Total interest-bearing deposits		219,355		2,808		2.54			220,443		3,766		3.39
Borrowings and subordinated debt		125,409		2,682		4.18			123,978		3,035		4.79
Total interest-bearing liabilities		344,764		5,490		3.14			344,421		6,801		3.89
Demand deposits		34,895							35,177
Other non-interest bearing liabilities		1,551							2,427
Stockholders’ equity		22,230							29,679
Total liabilities and stockholders’ equity	$	403,440						$	411,704
Net interest income			$	5,541						$	5,158
Net interest rate spread						2.69	%						2.22	%
Net earning assets	$	32,372						$	45,382
Net interest margin						2.91	%						2.67	%
Average interest-earning assets to average interest-bearing liabilities				109.39	%						113.18	%

(1) Calculated net of deferred loan costs and premium and allowance for loan losses.

(2) Securities include securities available for sale and held to maturity and FHLB stock.

The Bank intends to emphasize the growth in core deposits as the need for additional funds arises. In addition, management intends to supplement core funding with borrowings from the FHLB and higher-cost certificates of deposits, subject to the limitations discussed in “–Liquidity and Capital Resources,” below. In the near term, the Bank expects that the current low interest rate environment will continue, along with diminished levels of demand for residential and commercial loans. In addition, the elimination of interest and dividend income from the FNMA and FHLMC preferred stock and Lehman Brothers Holdings corporate bonds, and a reduction in dividend income from FHLB stock, will adversely affect the Company’s net interest income in future periods. These factors will cause the Bank’s net interest income and interest rate spread to remain relatively flat for at least the next several quarters.

Non-interest Income

Non-interest income decreased $445,000 to $118,000 for the quarter ended December 31, 2008 from $563,000 for the same quarter last year, including the OTTI write-down of $200,000 for Citigroup common stock. For the six months ended December 31, 2008, non-interest income decreased $9.2 million to a loss of $8.0 million from income of $1.1 million for the same period last year, primarily due to the total OTTI fiscal year-to-date write-down of $8.7 million. Non-interest income during the six months ended December 31, 2008 also reflected lower other income of $88,000 and losses from sales of investment securities as compared to the same periods last year.

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Non-interest Expense

Total non-interest expense for the quarter ended December 31, 2008 increased $450,000, or 15.4%, to $3.4 million compared to the same quarter last year, primarily due to increases in salaries and benefits expenses of $42,000, professional fees of $111,000, merger related expenses of $153,000 and other operating expenses of $144,000. For the six months ended December 31, 2008, non-interest expense increased $824,000, or 14.0%, to $6.7 million compared to the same period last year, primarily due to increases in salaries and benefits expenses of $72,000, professional fees of $225,000, expenses related to the pending merger with Middlesex of $153,000 and other operating expenses of $374,000. The increases for the quarter and six-month period in professional fees were primarily due to higher legal fees. In addition, the increases in other operating expenses were primarily due to higher expenses associated with problem loans and foreclosed properties and increased estimates for deposit insurance premium assessments, partially offset by decreases in advertising expenses.

The operating efficiency ratio (total non-interest expense divided by the sum of net interest income plus total non-interest income, excluding OTTI write-downs) for the quarter ended December 31, 2008 was 113.3% compared with 91.4% for the same quarter a year ago. The operating efficiency ratio for the six months ended December 31, 2008 was 108.7% compared with 93.6% for the same period a year ago.

Income Taxes

The benefit for income taxes increased to $2.8 million for the quarter ended December 31, 2008 due to recognition of an additional tax benefit of $2.5 million related to the Bank’s ordinary losses on FNMA and FHLMC preferred stocks as permitted by the Emergency Economic Stabilization Act (“EESA”). For the six months ended December 31, 2008, the benefit for income taxes increased to $3.7 million. The effective income tax benefit rate for the six months ended December 31, 2008 was 37.7% compared to 46.5% for the same period last year. On October 3, 2008, the EESA was enacted with a provision permitting banks to recognize losses related to FNMA and FHLMC preferred stocks as ordinary losses for tax purposes. The pre-tax losses for the comparative periods have also affected the effective tax rates and the utilization by the Company of certain tax preference items such as bank-owned life insurance, dividends received deductions and security corporation subsidiaries to reduce the statutory corporate tax rates.

Asset/Liability Management

A principal operating objective of the Bank is to produce stable earnings by achieving a favorable interest rate spread that can be sustained during fluctuations in prevailing interest rates. Since the Bank’s principal interest-earning assets generally have longer terms to maturity than its primary source of funds,i.e., deposit liabilities, increases in general interest rates will generally result in an increase in the Bank’s cost of funds before the yield on its asset portfolio adjusts upward. Financial institutions have generally sought to reduce their exposure to adverse changes in interest rates by attempting to achieve a closer match between the repricing periods of interest rate sensitive assets and liabilities. Such matching, however, is carefully monitored so as not to sacrifice net interest margin performance for the perfect matching of these interest rate sensitive instruments. The Bank has established an Asset/Liability Management Committee (“ALCO”) made up of the chief executive officer, the chief financial officer, the senior loan officer, and others to assess the asset/liability mix and recommend strategies that will enhance income while seeking to mitigate the Bank’s vulnerability to changes in interest rates. This committee meets regularly to discuss interest rate conditions and potential product lines that would enhance the Bank’s income performance.

Certain strategies have been implemented to improve the match between interest rate sensitive assets and liabilities. These strategies include, but are not limited to: daily monitoring of the Bank’s cash requirements, originating adjustable and fixed rate mortgage loans, both residential and commercial, for the Bank’s own portfolio, selling loans, managing the cost and structure of deposits, short and long-term borrowings and using matched borrowings to fund specific purchases of loan packages and large loan originations. Occasionally, management may choose to deviate from specific matching of maturities of assets and liabilities if an attractive opportunity to enhance yield becomes available.

ALCO modeling, which is performed quarterly with the assistance of an outside advisor, projects the Bank’s financial performance over the next twenty four months using loan and deposit projections, projections of changes in interest rates, and anticipated changes in other income and operating expenses to reveal the full impact of the Bank’s operating strategies on financial performance. The results of the ALCO process are reported to the Board of Directors at least on a quarterly basis.

Liquidity and Capital Resources

The Bank’s primary sources of funds consist of deposits, borrowings, repayment and prepayment of loans, sales of loans and securities, maturities and early calls of securities, and funds provided from operations. While scheduled repayments of loans and maturities of securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by the general level of interest rates, economic conditions, and competition. The Bank primarily uses its liquidity resources to fund existing and future loan commitments, to fund net deposit outflows, to invest in other interest-earning assets, to maintain liquidity, and to pay operating expenses.

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The Bank utilizes advances from the FHLB primarily in connection with its management of the interest rate sensitivity of its assets and liabilities. Total advances outstanding at December 31, 2008 amounted to $117.8 million. The Bank’s ability to borrow from the FHLB is dependent upon the amount and type of collateral the Bank has to secure the loans. Such collateral consists of, but is not limited to, one-to-four family owner-occupied residential property, multi-family residential property, commercial real estate and certain investment securities. As December 31, 2008, the Bank had a borrowing capacity with the FHLB to borrow an additional $38.4 million, for a total of $156.2 million.

A significant portion of the Bank’s liquidity consists of cash and cash equivalents, short-term investments and investment securities. The level of these assets is dependent upon the Bank’s operating, lending, and financing activities during any given period.

At December 31, 2008, the Company had outstanding commitments to originate loans of $2.3 million. Unused lines of credit and open commitments available to customers at December 31, 2008 amounted to $40.5 million, of which $21.9 million were home equity lines of credit. Certificates of deposit, which are scheduled to mature in one year or less, totaled $118.9 million at December 31, 2008. Based upon historical experience, management believes that a significant portion of such deposits will remain with the Bank.

At December 31, 2008, the Bank met all regulatory capital requirements necessary to qualify as “adequately capitalized,” having Tier 1 capital of $18.8 million and a Tier 1 leverage capital ratio of 4.73%, which was above the adequately capitalized level of $15.9 million or 4.0%. The Bank’s Tier 1 capital to risk-weighted assets ratio was 6.76%, which was above the adequately capitalized level of $11.1 million or 4.0%. In addition, with total capital of $22.3 million, the Bank’s total capital to risk-weighted assets ratio was 8.01%, which was above the adequately capitalized level of $22.2 million, or 8.0%. The FDIC may, however, impose higher leverage and risk-based capital requirements on the Bank when circumstances warrant.

On October 14, 2008, the U.S. Department of the Treasury announced that, using authority granted to Treasury under the EESA, Treasury would purchase senior preferred shares in U.S. banks in order to increase the flow of financing to U.S. businesses and consumers and to support the U.S. economy. After applications are submitted, Treasury determines eligibility and allocations for interested parties after consultation with the appropriate federal banking agency. Treasury has not yet published the terms on which mutual organizations such as the Company can participate in the Treasury’s Capital Purchase Program (“CPP”). The Company may apply for participation in the CPP. However, the Company is not required to accept its allocation if approved by Treasury.

Recent Accounting Pronouncements

In December 2007, the FASB issued Statement No. 141 (revised), “Business Combinations.” This Statement replaces FASB Statement No. 141, and applies to all business entities, including mutual entities that previously used the pooling-of-interests method of accounting for certain business combinations. Under Statement No. 141 (revised) an acquirer is required to recognize at fair value the assets acquired, liabilities assumed, and any non-controlling interest in the acquired at the acquisition date. This replaces the cost-allocation process under Statement No. 141, which resulted in the non-recognition of some assets and liabilities at the acquisition date and in measuring some assets and liabilities at amounts other than their fair values at the acquisition date. This Statement requires that acquisition costs and expected restructuring costs be recognized separately from the acquisition, and that the acquirer in a business combination achieved in stages recognize the identifiable assets and liabilities, as well as the non-controlling interest in the acquired, at the full amounts of their fair values. This Statement also requires an acquirer to recognize assets acquired and liabilities assumed arising from contractual contingencies as of the acquisition date, while Statement 141 allowed for the deferred recognition of pre-acquisition contingencies until certain recognition criteria were met, and an acquirer is only required to recognize assets or liabilities arising from all other contingencies if it is more likely than not that they meet the definition of an asset or a liability. Under this Statement, an acquirer is required to recognize contingent consideration at the acquisition date, whereas contingent consideration obligations usually were not recognized at the acquisition date under Statement 141. Further, this Statement eliminates the concept of negative goodwill and requires gain recognition in instances in which the total acquisition-date fair value of the identifiable net assets acquired exceeds the fair value of the consideration transferred plus any non-controlling interest in the acquired. This Statement makes significant amendments to other Statements and other authoritative guidance, and applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An entity may not apply it before that date.

In December 2007, the FASB issued Statement No. 160, “Non-controlling Interests in Consolidated Financial Statements, an amendment of ARB No. 51.” This Statement establishes accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a non-controlling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. This Statement is effective for fiscal years beginning on or after December 15, 2008, and is not expected to have a material impact on the Company’s consolidated financial statements.

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In March 2008, the FASB issued Statement No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133.” This Statement changes disclosure requirements for derivative instruments and hedging activities accounted for under Statement No. 133 and its related interpretations, including enhanced disclosures regarding use, methodology and financial impacts. This Statement is effective for fiscal years and interim periods beginning after November 15, 2008, and is not expected to have a material impact on the Company’s consolidated financial statements.

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk.

Not applicable.

ITEM 4. Controls and Procedures

(a) Evaluation of disclosure controls and procedures.

As required by Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the Company’s management conducted an evaluation with the participation of the Company’s Interim Chief Executive Officer and Chief Financial Officer, regarding the effectiveness of the Company’s disclosure controls and procedures, as of the end of the last fiscal quarter. Based upon that evaluation, the Interim Chief Executive Officer and Chief Financial Officer concluded that they believe the Company’s disclosure controls and procedures were effective as of December 31, 2008 to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. We intend to continue to review and document our disclosure controls and procedures, including our internal controls and procedures for financial reporting, and we may from time to time make changes to the disclosure controls and procedures to enhance their effectiveness and to ensure that our systems evolve with our business. In designing and evaluating the Company’s disclosure controls and procedures, the Company and its management recognize that any controls and procedures, no matter how well designed and operated, can provide only a reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating and implementing possible controls and procedures.

(b) Changes in internal controls over financial reporting.

There were no changes in the Company’s internal controls over financial reporting identified in connection with the Company’s evaluation of its disclosure controls and procedures that occurred during the Company’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect the Company’s internal control over financial reporting.

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PART II — OTHER INFORMATION

ITEM 1. Legal Proceedings

There were no new legal proceedings other than legal proceedings occurring in the ordinary course of business which, in the aggregate, involve amounts believed by management to be immaterial to the financial condition and operations of the Company or material developments in ongoing proceedings during the quarter ended December 31, 2008.

ITEM 1A. Risk Factors

A summary of the Company’s risk factors appears in Part I, Item 1A, “Risk Factors” in the Company’s Form 10-K for the fiscal year ended June 30, 2008. There have been no other material changes to the risk factors, except as discussed below.

We recognized a material write-down of various investment securities on September 30, 2008, which caused the Company to incur a substantial loss for that quarter, and we may need to recognize further write-downs in the future.

The Company owns shares of two series of preferred stock issued by the FNMA and the FHLMC that had aggregate amortized cost of $7.2 million and a fair value of $6.6 million at June 30, 2008. On September 7, 2008, the Federal Housing Finance Agency (“FHFA”) was appointed as conservator of both FNMA and FHLMC, and the U.S. Treasury Department disclosed that it had entered into a Senior Preferred Stock Purchase Agreement with each of FNMA and FHLMC, contemplating an investment of up to $100 billion in each entity. The senior preferred stock has a liquidation preference senior to all FNMA and FHLMC stock, including the two series of preferred stock that the Company owns. In addition, the terms of the senior preferred stock prohibit each of FNMA and FHLMC from declaring or paying any dividend or making any other distribution with respect to any stock other than the senior preferred stock without the consent of the U.S. Treasury Department. In connection with the appointment of the FHFA as conservator, the FHFA announced that it was eliminating the payment of all future dividends on all FNMA and FHLMC stock, including dividends on the two series of preferred stock that the Company owns. After assessing these events, on September 30, 2008, the Company recorded other-than-temporary impairment (“OTTI”) write-downs of $6.6 million related to its investments in preferred securities issued by FNMA and FHLMC.

In addition, on September 30, 2008 the Company recognized an OTTI charge of $1.9 million with respect to senior and subordinated debt securities issued by Lehman Brothers Holdings, Inc., which filed for bankruptcy protection on September 14, 2008. And on December 31, 2008, the Company recorded an OTTI charge of $200,000 related to its investment in common stock issued by Citigroup.

The Company has not recognized OTTI write-downs with respect to debt securities it owns that were issued by American General Financial Services and International Lease Finance Corporation, subsidiaries of American International Group Inc. (“AIG”). On September 16, 2008, AIG announced that it entered into a revolving credit facility with the Federal Reserve Bank of New York under which AIG may borrow up to $85 billion at a rate per annum equal to three-month LIBOR plus 8.50% secured by a pledge of all of the assets of AIG and its “material subsidiaries” including American General Financial Services and International Lease Finance Corporation. Since then the government has taken various measures to increase aid to AIG. At the same time, AIG reported a loss of $24.47 billion for its quarter ended September 30, 2008. As a result, the trading market for AIG debt securities has been irregular, making it difficult for the Company to ascertain the fair value of those holdings. As of December 31, 2008, the Company’s AIG securities had a cost of $3.0 million and an estimated fair value of $1.6 million. There can be no assurance, however, that the Company’s estimates of those fair values in fact reflect the amount that the Company would realize if it sold those securities at the present time, and there can be no assurance that the fair values of such securities will not decline further.

The write-down of various investment securities taken on September 30, 2008 materially reduced the Company and the Bank’s regulatory capital levels, and any further write-downs could further materially reduce regulatory capital levels.

The aggregate amount of the Company’s OTTI charges recognized for the quarter ended September 30, 2008 caused the Bank’s capital levels to fall below those thresholds necessary to qualify as “well capitalized.” Due to several factors, the Bank’s total risk-based capital has not fallen below 8.0% as of December 31, 2008, which would have resulted in the Bank being classified as “undercapitalized” for regulatory purposes. A primary factor was management’s determination that the Company’s AIG securities were not other than temporarily impaired. If, in the future, management determines that the AIG securities are other than temporarily impaired, or if other investment securities held by the Bank are determined to be other-than-temporarily impaired, the Bank could be classified as undercapitalized, and would then be subject to various regulatory restrictions and requirements. Among other things, an undercapitalized bank must submit to the FDIC and abide by a capital restoration plan acceptable to the FDIC. In addition, an

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undercapitalized bank may not accept, renew or roll over any brokered deposit or offer deposits rates with an effective yield that exceeds by more than 75 basis points the prevailing effective yields on insured deposits of comparable maturity in the relevant market area. There can be no assurance that the Bank will be able to submit an acceptable capital plan or implement such a plan in all material respects if it becomes undercapitalized. A bank that is undercapitalized and that fails to submit an acceptable capital restoration plan or that fails in any material respect to implement such a plan, would be subject to all of the provisions applicable to a “significantly undercapitalized” bank. The Bank has briefed the FDIC and the Division regarding developments relating to its investment securities. At the request of the FDIC and the Division, the Bank submitted a plan to restore the Bank to a “well capitalized” status generally and to increase its leverage capital ratio to at least 7.0%.

The Company has recently appointed an Interim President and Chief Executive Officer.

Pamela J. Montpelier, the President and Chief Executive Officer of the Company and the Bank, resigned effective October 21, 2008 from all of her positions with Service Bancorp, Inc., Service Bancorp, MHC and Strata Bank. Edward A. Hjerpe, III, who previously was appointed as Interim President and Chief Executive Officer of the Company and the Bank, continues to serve in that capacity. There is no guarantee that the transition between Ms. Montpelier and Mr. Hjerpe will not cause any interruption or that these events will not have an adverse effect on the Company’s operations.

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

(a) Not applicable.

(b) Not applicable.

(c) Not applicable.

ITEM 3. Defaults Upon Senior Securities

Not applicable.

ITEM 4. Submission of Matters to a Vote of Security Holders

Not applicable

ITEM 5. Other Information

Not applicable

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ITEM 6. Exhibits

Exhibits

3.1	Articles of Organization of Service Bancorp, Inc. (incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form SB-2 (SEC File No. 333-156851))
3.2	Articles of Amendment to Articles of Organization of Service Bancorp, Inc. (incorporated by reference to Exhibit 3.1(A) to the Company’s Quarterly Report on Form 10-QSB for the quarter ended March 31, 2004)
3.3	Bylaws of Service Bancorp, Inc. (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed October 22, 2008)
4.1	Form of Certificate representing the Company Common Stock (incorporated by reference to Exhibit 4 to the Company’s Registration Statement on Form SB-2 (SEC File No. 333-156851))
10.1	Change in Control Agreement dated as of October 28, 2008 by and between Mark L. Abbate, Strata Bank, Service Bancorp, Inc. and Service Bancorp, MHC
10.2	Change in Control Agreement dated as of October 28, 2008 by and between Amy Costello, Strata Bank, Service Bancorp, Inc. and Service Bancorp, MHC
10.3	Change in Control Agreement dated as of October 28, 2008 by and between Randal D. Webber, Strata Bank, Service Bancorp, Inc. and Service Bancorp, MHC
31.1	Certification of Interim Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.
31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.
32.1	Certification of Interim Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

In accordance with the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	SERVICE BANCORP, INC.
Date: February 13, 2009	By:	/s/ EDWARD A. HJERPE, III
		Edward A. Hjerpe, III
		Interim President and Chief Executive Officer

Date: February 13, 2009	By:	/s/ MARK L. ABBATE
		Mark L. Abbate
		Executive Vice President and Chief Financial Officer

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